Monday, October 17, 2016

Levinson on growth

Yes, growth is slow. Yes, the ultimate source of growth is productivity. But no, sclerotic productivity is not "just being ordinary." No, our economy is not generating as much productivity growth as is possible, so just get used to it. No, productivity does not fall randomly from the sky no matter what politicians do.

Mark starts well, with a nice and vivid review of the post WWII growth "miracles."

He stumbles a bit at the 1973 Yom Kippur war and oil embargo

"Politicians everywhere responded by putting energy high on their agendas. In the U.S., the crusade for “energy independence” led to energy efficiency standards, the creation of the Strategic Petroleum Reserve, large government investments in solar power and nuclear fusion, and price deregulation. [JC: ?? The 1970s had price controls, not deregulation!] But it wasn’t the price of gasoline that brought the long run of global prosperity to an end. It just diverted attention from a more fundamental problem: Productivity growth had slowed sharply."

"The consequences of the productivity bust were severe.."

More good descriptions of eurosclerosis follow. But you see him veer off course, as he sees little connection between the litany of ham-handed responses to the oil shock and the decline in productivity.

Briefly back to a sensible point

"Government leaders in the 1970s knew, or thought they knew, how to use traditional methods of economic management—adjusting interest rates, taxes and government spending—to restore an economy to health. But when it came to finding a fix for declining productivity growth, their toolbox was embarrassingly empty."

Let us speak the word: the methods of Keynesian demand-side economic management were, as any honest Keynesian will tell you, utterly unsuited to solving productivity, the ultimate "supply" problem. Given the Economist's enthusiasm for fiscal stimulus a bit more honesty on this one would be appreciated.

But then then he veers off course entirely

"Conservative politicians such as Margaret Thatcher in the U.K., Ronald Reagan in the U.S. and Helmut Kohl in West Germany swept into power, promising that freer markets and smaller government would reverse the decline, spur productivity and restore rapid growth."

"But these leaders’ policies—deregulation, privatization, lower tax rates, balanced budgets and rigid rules for monetary policy—proved no more successful at boosting productivity than the statist policies that had preceded them. Some insist that the conservative revolution stimulated an economic renaissance, but the facts say otherwise: Great Britain’s productivity grew far more slowly under Thatcher’s rule than during the miserable 1970s, and Reagan’s supply-side tax cuts brought no productivity improvement at all. [My emphasis] Even the few countries that seemed to buck the trend of sluggish productivity growth in the 1970s and 1980s, notably Japan, did so only temporarily. A few years later, they found themselves mired in the same productivity slump as everyone else.."

This is just a whopper of... what to call it... factual error.

The US embarked on a second boom from 1980 to 2000. See John Taylor's excellent response, "Take off the muzzle and the economy will roar" for more discussion, and the graph reproduced at the left. Call it the Reagan-Bush-Clinton boom if it makes you feel better. But the boom was real.

(Update: A correspondent writes "the author's claim that productivity growth was worse in the UK under Thatcher than in the 1970s is very wrong. Indeed, productivity growth was one area in which I thought there was wide agreement that the Thatcher period was a success (see, for example, Krugman's chapter on the UK in his book Peddling Prosperity).")

From off course, Levinson arrives at a strange harbor. His bottom line is the astonishing proposition that productivity growth just happens; manna from heaven (or not) dissociated from any economic or political structure:

"Productivity, in historical context, grows in fits and starts. Innovation surely has something to do with it, but we have precious little idea how to stimulate innovation—and no way at all to predict which innovations will lead to higher productivity..."

"It is tempting to think that we know how to do better, that there is some secret sauce that governments can ladle out to make economies grow faster than the norm. But despite glib talk about “pro-growth” economic policies, productivity growth is something over which governments have very little control. Rapid productivity growth has occurred in countries with low tax rates but also in nations where tax rates were sky-high. Slashing government regulations has unleashed productivity growth at some times and places but undermined it at others. The claim that freer markets and smaller governments are always better for productivity than a larger, more powerful state is not one that can be verified by the data."

I'm sorry, the data -- and the immense literature that study that data -- come to the opposite conclusion. There is a reason that this manna seems to fall on the US and not, say, on Haiti. There is a reason it falls on South Korea and not North Korea -- the most tragic but decisive controlled experiment known to economics.

Yes, the answers are not as simplistic as the minor tweaks represented by "pro-growth" policies of established parties in western democracies. But experience and formal analysis tell us clearly that innovation and productivity happen where there is rule of law, simple and predictable regulation, property rights, reasonable taxation, an open and competitive economy, and decent public infrastructure. These, politicians do have ample control over, and ample opportunity to screw up.

(Update and clarification. Levinson is thinking about the experience over time in single countries. There, indeed, the variation of policies is small, and its correlation with growth hard to tease out. Growth takes a while to get going or to kill, and causality can run both ways. Countries often reform after bad times, and squeeze the golden goose after good times. I'm thinking more about the variation across countries. If you look at the yawning gaps in "pro-growth" policy across US, UK, China, India, North Korea, say, you see also yawning gaps in productivity.)

"Here is the lesson: What some economists now call “secular stagnation” might better be termed “ordinary performance.” ...

"Ever since the Golden Age vanished amid the gasoline lines of 1973, political leaders in every wealthy country have insisted that the right policies will bring back those heady days. Voters who have been trained to expect that their leaders can deliver something more than ordinary are likely to find reality disappointing."

I've got news for Mr. Levinson. "Ordinary performance" is what people experienced from the beginning of time to about 1750. Steady grinding poverty, 0% growth rate, each farming in his parents' footsteps. Even 2% was the result of an amazing and unprecedented set of "pro-growth" political institutions.

Not only can we do better we can do worse. A lot worse.

If good policy does not help, then it follows that bad policies do not hurt. No matter how much our politicians abandon "pro-growth" policies, to nativism, trade barriers, over-regualation, legal capture, arbitrarily high taxes, more controlled markets and larger government, growth will just bumble along at 2% anyway. Both the US and UK may soon put that one to the test.

Note: I use block quotes and embedded graphs. These show up on the original blogger verision of this post. I notice they get garbled at various other feeds. If you want better formatting, come back to the original

I can't agree more on "innovation and productivity happen where there is rule of law, simple and predictable regulation, property rights, reasonable taxation, an open and competitive economy, and decent public infrastructure." China is a good example of this proposition in the last three decades, although we still lag behind in "rule of law","predictable regulation" and perhaps formal "property rights". In China, promotion prospects and competition between local governments provide local officer strong incentives and pressure to come up with all kinds of policies to stimulate local economies, such as offering firms tax reduction, bank loan, and decent public infrastructure.

?! Reagan was a Keynesian – his tax cuts, which were not offset by reductions in expenditures, were classical fiscal stimulus, with the anticipated impact on growth. But they weren't supply-side: these were cuts that boosted personal incomes. They also led to high deficits – government expenditures rose, Reagan launched Star Wars without cuts elsewhere – and also high real interest rates, which impeded investment. Look back on the semiconductor industry bemoaning that because their cost of capital was high they couldn't compete with Japan in building big "fabs". (With hind sight, that turned out to be fortunate.)

In real terms growth in federal outlays slowed down fairly significantly during the Reagan years. If you take out net interest payments (those 'high real interest rates' you refer to) primary spending was 19.4% of GDP in 1981 compared to 17.5% in 1989- the lowest it had been in 15 years at that point in time. Same story with the primary deficit.

I have a hard time seeing how a long term, across the board reduction in marginal income tax rates, combined with a slower rate of government spending growth fits any definition of Keynesian stimulus.

"Look back on the semiconductor industry bemoaning that because their cost of capital was high they couldn't compete with Japan in building big fabs."

Even with high real interest rates, semiconductor companies can still sell equity shares.

Instead, I think what you mean is that given U. S. budget deficits that were giving investors a high real risk free rate of return (government bonds), equity shares had a higher clearing hurdle to draw investors. This is the crowd out effect that is often referred to and it has two parts - first a high real borrowing rate dictated by the central bank AND a federal government willing to borrow at that rate.

You can have a high real interest rate environment but little in terms of high real returns - Fed jacks up interest rates during a budget surplus.

And if memory serves, the largest impediment to building semi-conductor chip manufacturing facilities in the U. S. is environmental regulation (then and now), not so much cost of capital.

But you are correct, Reagan pushed through his tax cuts without offsetting them with spending cuts elsewhere. Instead, he later increased taxes.

To over-ride the Presidential veto requires both the House, under Democratic control, and the Senate, under Republican control in 1982, to have a 2/3rds majority. I don't think Tip was completely in control. There were also supplementals in each of the following years that Reagan signed off on. They came to a budget resolution process later in the '80s, that guided them into the '90s.

Much as it pains me to say so, that was only true until the last year or two of the Carter Administration. Much of what we think of as the "Reagan Revolution" began then, and at the time, tax-cutting and deregulation were bipartisan issues.

Much of the legislation that became the 1981 Economic Recovery and Tax Act (ERTA) was originally propounded by the Joint Economic Committee, co-chaired by Lloyd Bentsen of Texas and IIRC Senator Roth (of Kemp-Roth fame) of Delaware.

And there was a huge (YUUGE!) deregulatory effort in that timeframe as well: natural gas was effectively deregulated and so was oil, at least in part. The trucking industry was deregulated--breaking the Teamsters' Union stranglehold--and of course, perhaps most famously, the commercial aviation industry.

I believe it is important to distinguish between the level of productivity and its growth rate. I think there is greater consensus that institutional reforms and greater economic freedom, at least in some areas, raise the level of productivity (have my own article on the effect of EF on productivity in Latin America vs. OECD countries, which are generally positive but stronger in the OECD). However, there is less consensus regarding their effect on longer-run growth. Several studies (e.g. Zachariadis, 2003; Ha and Howitt, 2007) find a positive correlation between productivity growth and R&D intensity or the rate of patenting (I have an article showing a positive effect on the real interest rate also). However, it is not clear which government policies are important on encouraging R&D and how much. Funding basic research should be, but even protection of intellectual property can be a double-edged sword. Much of the acceleration in productivity growth in the 1990s and early 2000s was due to the ICT revolution. I doubt that Reagan deserves much credit for that. If anything, the roots lie in WWII and right after, with advances in Turing machines, semiconductors, circuits, laser technology, etc. which, by entering the technology toolbox, made everything else possible.

A = Productivity (With meaningless units that are open to the Cambridge Critique). Also if I understand the calculation correctly, the capital being referred to is capital goods (machinery, land, buildings, etc.), not monetary capital. And so, it seems that the equation does not include the beneficial real effects on trade generated by everyone using a common currency.

My own thinking regarding productivity is that it should be expressed this way:

Our present situation coming out of the Great Recession of 2007 to 2009 (due to what was happening in the retail housing industry) with the Financial Crisis of 2008 in the middle of that (due to what was happening in the wholesale financial markets with financial derivatives of the housing market) with Fed intervention to steady market forces is similar to the World War II situation where the Fed and Federal Government reach an accord to finance the war. This results in huge debts but due to good productive growth in the 1950s and 1960s the debt-to-GDP will be decreased significantly, by over half. So, where is our growth potential now?

That is why I don’t think Cochrane's weeding or Taylor’s regulatory reform, tax reform, budget reform, and monetary reform are the prescriptions for the best growth that we would be capable of achieving. I think we should make deep structural reforms:

1. Restructuring the economy to emphasize the productive sectors. The U.S. doesn’t have to be a net-exporter, just do more exporting, especially of goods. We already are an excellent exporter of services – over 50% of those services utilize digital technology. We need to put more emphasis on the high-end of technology for design, R&D, testing and analysis, and manufacture.

2. We need to upgrade of educational system to emphasize technology – like we did after Sputnik.

3. We need to revamp our tax system – maybe a flat tax to replace graduated income taxes. Then when we wanted to have a tax cut to stimulate consumer spending it would have more impact – Bush’s big tax cuts had little effect on the lower end where the tax burden was mainly on the upper end.

4. And in our globalized financial world where over one trillion dollars gets moved around every business day, and after the results of the Financial Crisis of 2008, I suspect that the allocation of capital to the needed areas of the world where productivity would be in more uplifting (than it is already) sectors is somehow missing the mark.

These measures will allow fiscal policy to come to the fore and work with the monetary policy which we have knowledge of. We have relied too much on monetary policy and we are reaching the limits of monetary policy. If we took a lesson from the ‘60s and the Greatest Generation to put a little more emphasis on productivity rather than economic stability (aka ‘efficiency’) I think we could get out of this hysteresis we seem to be in.

Investors and the public are beginning to realize that central banks can only do so much through printing money and lowering interest rates. America continues to spend nearly $2,500 more than it takes in each year per man woman and child, such deficits were unheard of in the past and are unsustainable.

Still all indications and forecast predict slow growth as far as the eye can see. Details of the last job report touted as proof of an economic resurgence indicate the job market is a lot weaker than the headline number leads us to believe. The piece below explores reasons for this lack of growth.

Agreed. Though this will likely need to occur at the higher education level. It's funny, most colleges that offer 4 year degrees insist that graduates in technological fields receive a "well rounded" education. Meaning a chemical engineer will be required to take courses from the humanities - history, politics, economics, the arts, etc. I wonder if this is emphasis is misplaced. Perhaps those courses should be replaced with mandatory internships, meaning you work in your field while getting your education?

I think we need to go further than a flat tax system - though it is a good place to start. In the same way that monetary policy is adjusted (by an body independent of Congress) over multiple business cycles, I think tax policy needs to be adjusted in the same way - by an body independent of Congress.

Otherwise, it wouldn't be too long after a flat tax is implemented (basically the first flat tax recession) that Congress would re-introduce the myriad of exceptions, carve outs, and special cases that plagues the tax code today.

"We have relied too much on monetary policy and we are reaching the limits of monetary policy."

Agreed again. But monetary policy has one important feature that is missing from other economic measures - it is insulated in large part from political pressures. If a body responsible for tax policy changes could reach that level of independence, drastic improvements in economic performance could be realized.

I don't concede that monetary policy should consist of quantitative easing. When the U. S. Federal Reserve Board of Governors was created in 1913, their powers were limited to setting reserve requirements and setting the interest rate at which they would lend from the discount window. Open market operations and the Federal Open Market Committee did not exist until the Banking Act of 1933.

"...national debt is money due by the people to the people, so it's not debt at all..."

If the Keynesian view that debt is money due by all the people to all the people, then there would be no reason for QE at all - would there?

Instead the national debt is serviced by tax revenue from one group of people (tax payers from the country in debt) to another group of people (bond purchasers from any country). True, there is overlap between the two - tax payers and bond purchasers, but the two groups are not identical.

The role of a central bank, and our Fed, is to provide economic stability and act as the lender of last resort during a crisis. That is right out of the 19th Century of European history. As the United States has grown from its inception, the economy has become less regional and more national and international, the role of the federal government has evolved, and the role of our Federal Reserve has now taken on an unprecedented international role because of a crisis as the lender of last resort to re-establish stability in international as well as our national market – and the U.S. is over 50% of international monetary flows and the dollar is the world’s reserve currency without question. If there is any doubt about the worth of the dollar there was no better indication of this than when Lehman Brothers failed and the international rush was to the dollar and not to gold – the price of gold dropped and the value of the dollar shot up.

If you want an indication of how quickly the role of our Fed changed you need look no further than the Fed balance sheets – weeks before Lehman failed (less than $1 trillion), the end of the year in 2008 (over $2 trillion) after an accord was reached with the G-7 Central Banks October 10th 2008 to coordinate a response to the Crisis, and now (over $4 trillion). The Fed has assets on its balance sheet as a result of the Crisis that not only show what it had to do to shore up our banking system, by exchanging safe treasuries for questionable bank loans to include working its way out into the yield curve into long-term securities, and activity into the international arena with other central banks and into the international money markets to provide safe dollar denominated assets for assets of lessor quality in order to provide stability and liquidity to keep the world’s financial system functioning so market forces could be restored.

"...and the role of our Federal Reserve has now taken on an unprecedented international role because of a crisis as the lender of last resort to re-establish stability in international as well as our national market..."

With the Fed's fingers in so many pies, perhaps there needs to be someone / some group at the federal level looking out for the home team?

"...to provide safe dollar denominated assets for assets of lessor quality in order to provide stability and liquidity to keep the world’s financial system functioning so market forces could be restored..."

And those Fed / market forces have resulted in how much real U. S. growth? Maybe we need to try something else?

"We have relied too much on monetary policy and we are reaching the limits of monetary policy."

Frank --- Your almost there. I think we have stretched monetary policy about as far as it can go for the present. That's why I advocate restructuring our economy so that fiscal policy will be more effective in stimulating growth.

"...experience and formal analysis tell us clearly that innovation and productivity happen where there is rule of law, simple and predictable regulation, property rights, reasonable taxation, an open and competitive economy, and decent public infrastructure."

I agree wholeheartedly. In my opinion, such policies encourage innovation indirectly by encouraging private investment. There is little incentive to work hard on innovating in areas where private investment is unlikely to be profitable. I think that Silicon Valley is a great example of the link between private investment and innovation.

Europe stopped growing in the post-war era when the polity decided that redistribution was ranked higher than growth in their preference orderings. We are heading the same way in the US. Thus, we are suffering from political sclerosis and regulatory stagnation. Politicians thrive on favors to special interests, just look at how our elected officials get rich in office. It's a natural consequence of simple majority democracy. In today's US, successful entrepreneurs are vilified rather than celebrated. Labor force participation rates are down, human capital is not growing, education is dismal, investments discouraged, capital markets overregulated -- it is a wonder we are growing at all.

Your assertion about Europe having stopped growing is obviously false, unless by "postwar" you mean the 2008 war in Georgia, see e.g. real GDP per capita since the Reagan years: http://4.bp.blogspot.com/-oVnlnDk3Ytw/T70gEvNx29I/AAAAAAAABBc/Hbag6aWyM4o/s1600/Real+GDP+per+Capita+Growth.png

Perhaps productivity is falling due to a weakness in aggregate demand caused by too tight money. We see global deflation which does suggest too-tight money which would also result in lower wages, decreasing incentives to invest in plant and equipment.

But money isn't really that tight, is it? Maybe you should see it as some sort of confirmation bias if you think "it HAS TO BE tight money because demand is low". The thing is: too many countries fail to experience high (or non low) growth rate regardless of their different fiscal and monetary policies.

Just a few days before this post went up Janet Yellen gave a speech - indeed, a kind of desperate clarion call - urging vast "new research" regarding some of the most basic claims of Keynesian economics:

http://www.federalreserve.gov/newsevents/speech/yellen20161014a.htm

I'm all for new research, but it seems odd to me that Yellen seems to be admitting that there isn't much actual research to support some of the most basic and insistent Keynesian macroeconomic notions.

That's interesting but it doesn't really address Yellen's admission that many Keynesian certainties seem to be rather thinly supported by actual research, although Keynesian macroeconomists have never wanted for certitude. Keynesianism has been around for a very long time, and I have to ask why the new research Yellen cries out for was not conducted long ago. It's really basic stuff. And if there is a good reason such research was not conducted in the past (macroeconomics does not lend itself to experiments as easily as other sciences, after all), what makes Yellen (or anyone) think it can be conducted now?

"... admission that many Keynesian certainties seem to be rather thinly supported by actual research."

I have read the entire speech, and I don't see any mention in it of the Keynesian certainties that you are referring to. The additional research that she asks for is found in these statement:

1. "More research is needed, however, to better understand the influence of movements in aggregate demand on aggregate supply."

2. "But I believe we have a lot more to learn about the ways in which changes in underwriting standards and other determinants of credit availability interact with interest rates to affect such things as consumer spending, housing demand and home prices, business investment (especially for small firms), and the formation of new firms."

If there are Keynesian certainties that are to be inferred here, then I am not in a position to infer them.

Is it a Keynesian certainty that aggregate demand has no long term effect on aggregate supply?

Is it a Keynesian certainty that credit supply / demand is determined by price (interest rate) alone - that intermediation and underwriting standards don't matter?

In the Financial Times Cardiff Garcia described Yellen's address this way (http://ftalphaville.ft.com/2016/10/18/2177454/janet-yellen-to-macroeconomists-that-whole-supply-demand-thing-might-need-a-rethink/):

"Janet Yellen’s speech on Friday to the Boston Fed conference was like a greatest-hits collection of the frustrations long expressed by advocates of more-stimulative demand policy. One of those frustrations has been rooted in the belief that a more aggressive counter-cyclical response to recessions doesn’t merely jumpstart the economy again, but also prevents semi-permanent damage to the economy’s very capacity for growth — in other words, weak demand now can damage potential supply into the future."

That seems to me to be a diplomatic way of pointing out that Yellen and the administration she serves have been receiving a great deal of criticism from paleo- or neo- or whatever-Keynesians demanding more demand stimulus, and her call for "further research" is a polite way of saying there's not much to support that insistence. Whether one wants to consider those critics as speaking from Keynesian certitudes of not, it seems to me that every single thing Yellen is calling to be researched could just as well have been researched a long time ago. Either there is a good reason it wasn't done, or there isn't, but either way that seems very odd to me.

You don't have to be a Keynesian to think now would be a good time for governments to borrow money to fix roads, bridges, water and sewer infrastructure. Or maybe put some low interest rate money into fixing the rail bottleneck at Chicago.

I don't think that literally "printing" money does any good except in the deepest of liquidity traps.

Globally we have a problem with excess savings. Market interest rates around the world confirm this. A government that taxed today to build infrastructure is creating a long lived asset is in effect "saving" - using today's income to create an asset that will last 50 plus years. We do not need more saving right now. If you are building a fifty year asset it makes sense to spread the payments for that asset over a thirty to fifty year period.

Even using current taxes to pay for accumulated deferred maintenance would be "saving" at this point. It would make sense to finance catch up maintenance over a ten year period and then to maintain going forward from current revenue. An increase in gasoline taxes to pay for building and maintaining roads and bridges etc would be in order - you can call it a user fee if you prefer.

"I don't think that literally printing money does any good except in the deepest of liquidity traps."

Sure it does. You describe that good in your later statements - that money printed pays workers and suppliers to create an asset that will last 50 plus years.

"Globally we have a problem with excess savings. Market interest rates around the world confirm this."

Well gosh, given the choice between the government borrowing money very cheaply or printing money even more cheaply - why shouldn't the government just print the money?

"A government that taxed today to build infrastructure is creating a long lived asset..."

A government that printed money today to build infrastructure is creating a long lived asset. A government that borrowed money today to build infrastructure is creating a long lived asset.

You haven't answered the question.

"If you are building a fifty year asset it makes sense to spread the payments for that asset over a thirty to fifty year period."

The payments for the asset are made as it is constructed. The question becomes should those payments come from direct taxation, deferred taxation (borrowing), or money printing. You have not established why borrowing is the best option.

1. Printing money is cheaper than borrowing it2. In either case you are getting a long lived asset

"If good policy does not help, then it follows that bad policies do not hurt."

Agree with the sentiment. If we view the economy as being accurately modeled by some sufficiently complex function then the derivative of that function with respect to any policy variable should be continuous as we perturb each of the policy variables a little more, a little less.

By long term historical standards two per cent per capita growth is pretty good. I personally think there is too much doom and gloom about the consequences of two percent. We should shoot for higher but not lose sight of the fact that two percent is pretty good (even one percent is not the end of the world).

Thanks to a few abusers I am now moderating comments. I welcome thoughtful disagreement. I will block comments with insulting or abusive language. I'm also blocking totally inane comments. Try to make some sense. I am much more likely to allow critical comments if you have the honesty and courage to use your real name.

About Me and This Blog

This is a blog of news, views, and commentary, from a humorous free-market point of view. After one too many rants at the dinner table, my kids called me "the grumpy economist," and hence this blog and its title.
In real life I'm a Senior Fellow of the Hoover Institution at Stanford. I was formerly a professor at the University of Chicago Booth School of Business. I'm also an adjunct scholar of the Cato Institute. I'm not really grumpy by the way!